Finance under stress: US decoupling and China opening-up
Finance under stress: US decouples as China opens-up
WRITTEN BY MIRIAM L. CAMPANELLA
22 July 2020
With Sino-American relations at an all-time low due to the COVID-19 pandemic, a frightening new level of confrontation is developing within international finance. In an act largely seen as designed to punish China for the spread of the virus, the Trump administration is developing measures to de-list Chinese corporations and prohibit US financial investments in China. In a continuation of the last two years of trade and financial sanctions, the Trump administration seems determined to decouple China from the international financial regime.
While financial sanctions have utilised the US dollar to disconnect China from the circuit of US institutions, decoupling China from global capital markets would involve cutting Beijing off from the most globalised aspect of the economy, the global financial system. As China's capital markets have grown exponentially in recent decades, Beijing has steadily opened these markets to foreign investors. The Trump administration’s efforts at decoupling China, if implemented, would trigger seismic consequences, not just for Beijing but also for the entire US financial industry.
A wider analysis would suggest foreign stakeholders are being lured to China in the hope of seizing new opportunities. The question is whether such opportunities will stand in the way of America's intended financial decoupling, and help restore open and competitive financial markets.
China’s market appeal
The primary attraction to China’s capital market stems from its sheer size. It is currently second only to that of the United States, with the opening of financial markets being embraced by Chinese policymakers. This move has taken place in a variety of ways designed to provide overseas investors with access to China’s equity, bond, and other markets. The number of investment funds in China has grown substantially, with many partly owned by international firms, a positive indication of the maturing of China's capital markets, and the growth of investment funds seems to be staying the course. The recent financial regulatory developments present many new business opportunities for foreign investors and financial institutions. Over time this could lead to greater competition, more innovation, and better quality of service.
Robert Zoellick, former president of the World Bank, has called attention to the danger of financial decoupling to the global financial system, and the return of a financial Iron Curtain between East and West.
Despite the effects of the COVID-19 pandemic, the opening up of China's financial markets remains attractive. Since March this year, the process has included removing caps on foreign ownership stakes in Chinese joint ventures. Goldman Sachs and Morgan Stanley received approval to take the majority (51 per cent) ownership stakes in their Chinese securities subsidiaries. This move, and the 1 April ruling to lift caps on foreign firms (previously required to maintain a minority stake in a joint venture with a domestic Chinese partner), should be seen as a key indicator of Beijing's willingness to pursue a path to full international financial integration.
Savings also play a key role. China has the third highest savings rate in the world, far higher than that of the United States, Japan, and the European Union. In 2019, China had a savings rate of 35 per cent of GDP, this dwarfed America's 7 per cent, the Eurozone's 12.9 per cent, and even Japan's 27.3 per cent.
China's soaring Asset under Management industry
In just 20 years, large saving volumes have fed China's Asset under Management Industry (AuM), which has quickly reached great heights. This industry is a vital source of economic growth as an intermediary in savings investment and as a provider of the liquidity needed to ensure the smooth functioning of both Chinese and international capital markets. China's fund management firms have achieved unrivalled growth in both size and maturity – growing their AuM from RMB10.4 billion ($1.2 billion) in 1998 to RMB12.6 trillion ($2 trillion) today.
The effects of COVID-19 may accelerate a global repositioning in the AuM industry as mature markets like the US take a significant hit to portfolio valuations. In 2021 China will position itself as the AuM global hub, leading the Asian asset-management industry. McKinsey forecast this alone will generate revenues as high as $70 billion.
Another attraction, still underestimated, is China’s $13 trillion bond market; it offers yields higher than those in “safer” developed economies. This may prove even more lucrative due to the differing debt dynamics resulting from the COVID-19 pandemic. Rajeev De Mello argues that developed countries have deployed aggressive fiscal measures, through tax cuts, employment subsidies, credit guarantees, and capital expenditure to backstop their central banks’ purchases of riskier assets; these fiscal policies will, in all likelihood, reduce the tail risk of a recession.
However, these measures have, at the same time, exponentially increased government debt, with a resulting substantial increase in the bond supply. In contrast to past crises, when governments were eager to return to sustainable deficits and lower debt, this time, as De Mello observes, “the low cost of financing large deficits removes the incentives for prudence, consequently government debt is set to grow rapidly in the US and other developed countries”.
In the end, “whopping debts in developed countries have ultra-low or negative bond yields” so that investing in developed countries bonds is becoming unappealing to investors anxious to build balanced portfolios. These bonds ultimately provide “limited protection to further weakening in the economy while generating no returns when the economy is performing well”.
A mix of massive debt volumes incurred by developed economies due to COVID-19, central banks' ultra-accommodative policies, and yields approaching zero have prompted surprising changes. Foreign-investment managers of Japanese funds, known for their domestic bias, have started to diversify, or take more risks, in emerging Asian countries to safeguard returns in their portfolios. At the same time, China’s policy-makers’ decided to step up stimulus support for their virus-ravaged economy while simultaneously choosing not to involve the People’s Bank of China in quantitative easing, this was a move seen positively by foreign investors who now consider China’s renminbi-denominated bond market — the world’s third-largest — as a new refuge.
The extra yield offered to investors on Chinese debt, almost 2 percentage points compared with US Treasuries, explains foreign investors’ close monitoring of China’s offshore bond market. Last March, offshore investors poured in $10.7 billion, aided by Chinese bonds’ inclusion in global benchmark indices, and traders said the pick-up in foreign buying had continued.
In April, some $44 billion of US Treasury securities were sold, reducing total foreign holdings to $6.7 trillion, according to the Treasury Department’s Treasury International Capital (TIC) data, with the foreign share of the ballooning US Treasury debt ($24.9 trillion) dropping to 27.1%, the lowest since March 2008. These numbers, according to Hayden Briscoe, Asia-Pacific head at UBS, represent the single biggest change in capital markets in anybody’s lifetime. As investors dumped $44 billion in US Treasuries, they reinvested in China’s offshore bond market. Recent data from the US bond market signalled these swings and showed that foreign investors’ appetite for T-Bonds is fading.
A further interesting aspect is that the dumping of $44 billion in T-bonds by foreign investors coincided with the peak growth of the ‘mountain’ of US Treasury securities at $1.33 trillion. So this begs the question of who bought $44 billion in US bonds? Reading through the numbers, it emerges that US buyers had mostly bought them. The diminishing quota of foreign buyers, and the increasing size held by home investors, including federal entities of all kinds, tell us a new story is emerging, that the US debt may go the way of Japan’s, namely being owned by Americans themselves.
Here, the dynamics of debt in China diverges from the US; the former has mostly maintained a “normal” trajectory. Having discarded the option of quantitative easing and zero interest rates, as adopted by the US Federal Reserve, Chinese policymakers stuck to positive returns on the country’s bonds. The argument is clearly explained by Yi Gang, governor of the People’s Bank of China: “Maintaining positive interest rates and an upward-inclined yield curve is generally conducive to the economic entities, and in line with the Chinese people’s saving culture, thus beneficial to the sustainable development of the economy”. It is hardly surprising that this argument has lured domestic and foreign investors.
In conclusion
President Trump's directive for halting plans of the Federal Retirement Thrift Investment Board, a $600 billion pension fund for US federal government employees, and shifting some of its investments (11 per cent) into a new international shares index, including Chinese stock, has officially opened a new stage in US-China financial decoupling. Going down the path of decoupling is a far riskier game than tariff wars or even financial sanctions.
Robert Zoellick, former president of the World Bank, has called attention to the danger of financial decoupling to the global financial system, and the return of a financial Iron Curtain between East and West. This decoupling may indeed be irreversible, and foreshadow the beginning of a new conventional arms race with China, with all its consequent strategic instability and risks. Ultimately, as Henry M. Paulson warns “If you disconnect from others, you can certainly insulate yourself from some risks. But, frankly, you do not end up stronger and you create other risks in the process”.
DISCLAIMER: All views expressed are those of the writer and do not necessarily represent that of the 9DASHLINE.com platform.
Author biography
Miriam L. Campanella is a Senior Fellow at ECIPE, and a former Jean Monnet professor at the University of Turin. Between 1980 and 1994, Professor Campanella was based at the MIT Centre for International Studies, where she conducted research on general system theories and the economics of complex systems. Image credit: Leslin_Liu/Pixabay